Is Montenegro the next victim of the "one belt, one road" project ?

During the last 5 years, China helped numerous emerging countries from South-East Asia and Eastern Europe to develop their transportation and energy infrastructures through its Belt Road Initiative (BRI) allowing, as such, the creation of key transportation routes between Asia and Europe. However, this help did not come for free and took, most of the time, the form of loans granted with several questionable and potentially harmful conditions for the economy of debtors country. In this sense, it appears interesting to analyze the case of Montenegro, which is one of the latest country to have agreed to such loan, in order to try to perceive the potential  impact of this investment on the montenegrin economy and see if we can extract some investment opportunities from it.

Quick recap of the Belt Road Initiative

Before starting to analyze the impact of the chinese investment in Montenegro,  let's make a quick recap of the nature and goal of the BRI as well as of the strategy at play behind it.

The BRI was launched by the chinese president Xi Jinping in 2013 in order to create an economic and maritim economic belt around the ancient silk road which linked Asia to Europe. As such, it was promote by the chinese government as a win/win deal for both China and partners countries which agreed to be part of it and promote as an opportunity for developping countries to developp their infrastructure with the help of the chinese investments (operate mostly through loans) to finally be able to enter the world trade space as major commercial cross-road capable of attracting massive FDI.

However, behind this narrative the reality appears to be slightly different for many countries part of the BRI as shows the 2018 report of the Center for Global development. Indeed, due to their current economical endebtment and political regime, many countries such as Afghanistan, Egypt or Ukraine show current signs of potential difficulties to honour their future loans repayments schedules and others like Pakistan or Montenegro even appears to be at risk of default in the years to come. Also, despite looser conditions to grant the loans than the World Bank, China request most of the time that chinese corporations build the infrastructure and in the event of default that the debtor country grant a concession of many decade to China on those same infrastructures like in the case of Sri Lanka where in exchange of a massive haircut on its debt, the government agreed to grant China a 99 years concession on its brand new seaport.

So as we can see trough these massive loans and particular contracts with developping economies, China is currently building at some costs a grid of infrastructures that will allow it to really dethrone the USA on the world trade scene once its finished.

The Montenegro highway case

The idea of constructing an highway linking the Adriatic cost to Serbia is not new, as shows the two reports from 2006 and 2012 conducted by the french firm Louis Berger and the US company URS which both concluded that this project was not viable due to the lack of traffic in the region. Nonetheless,  despite the conclusion of these previous reports, in 2014, China conducted its own research and decided to grant trough its BRI initiative a dollar denominated loan of approximately €800 million in order to build the first of the three parts of the montenegrin highway. However, despite the apparent attractive terms of this loan ( 2% interest rate, 20 years repayment schedule and a 6 year grace period) the management of this contract by the montenegrin government turned it into a major threat for the country economy. Indeed, even though the loan exhibit attractive terms, it also required that most of the building be performed by a chinese construction corporation hiring mostly chinese workers, and created a very loose fiscal regime for this company preventing any potential rippling effects from the creation of those infrastructures on the local economy. Moreover, the government omitted a vital turnpike from its original blueprint and did not see fit to hedge against the currency risk increasing the total cost of this first part to more than 1 billion which by comparison represents approximately 1/4 of Montenegro's GDP.

Investment opportunities

Given the current situation of the montenegrin economy, we can see that the additional cost of approximately €1 billion for the remaining two parts of this highway is likely to force Montenegro into default, all the more so that the government announced to be determined to finish this project at all cost. Knowing that, it could seem interesting to short on the Stuttgart stock market, Montenegro's Sovereign bonds with a maturity after the start of the repayment schedule such as XS1807201899 and potentially couple this with a long on the USD/EUR if the greenback appears to be bullish while Montenegro is approaching default. 

Moreover, it is interesting to see that during the last years, chinese construction corporation have received from the BRI initiative the majority of their contracts to the extent of relying today nearly solely on it. Yet, as we've pointed out earlier, the BRI strategy consists mainly in according big loans to developping countries in order to allow the construction of brand new infrastructures and then get decades-long concessions on it. In other words, most of the activity of the biggest chinese construction firms rely on loans that will most likely for the most part default. In this sense, given the current trade war and the inner chinese economic problems the big question is to know if the chinese growth allows the substainability over the years of this economic expansion knowing the current level of corporate debt in China.

Nonetheless, the problem in China is that the government could at any time change the rule of the game so if you want to bet on the possible meltdown of the chinese banking sector that could result of this situation I can only encourage you to be extremely cautious in your analysis and not rule out the regulatory risk.